The trend toward greater official scrutiny of tax breaks designed to benefit homebuyers means financial advisors may want to caution clients who purchase residential properties about the conditions for claiming these breaks — and the new importance of supporting documentation.

This is especially the case as tax authorities are boosting supervision of tax benefits — specifically the principal residence exemption from capital gains tax and the New Housing Rebate (NHR), a program under the Excise Tax Act (ETA) — as Canada’s residential real estate continues to soar, with concerns that many homes are being bought and sold purely for profit.

For example, in a February decision from the Tax Court of Canada, Mohammad Feizmohammadi v. The Queen, the Canada Revenue Agency (CRA) challenged the sale of a one-bedroom condo on Yonge Street in the North York neighbourhood Toronto. The CRA had reassessed the taxpayer and disallowed a claim for the principal residence exemption for the condo. The taxpayer appealed.

The facts were simple. The taxpayer took possession of the newly built condo in May 2009 and became the owner in November 2009 when the transaction closed. The purchase price was $211,833. The condo was sold a few months later, in January 2010, for $277,000. The sale was not reported on the taxpayer’s 2010 tax return. In addition, the CRA noted that the taxpayer and his wife, who at times acted as a real estate agent, bought and sold several other properties between 2007 and 2011.

Although the taxpayer and his wife stated that they and their university aged son lived in the condo, and that it was their principal residence prior to the sale in 2010, the court did not accept that evidence.

Seemingly innocuous pieces of evidence were ultimately decisive in dismissing the taxpayer’s appeal, including the 2009 listing agreement that indicated a tenant was occupying the condo. The court also focused on utility bills for the condo that showed virtually no power usage during the period of ownership. Whether no one was using power, or someone else was paying it for, the court noted that “in either case, it is incompatible with the [taxpayer’s] family living in the Yonge Street property.”

Mostly on the basis of this evidence, as well as a CRA questionnaire in which the taxpayer indicated that he did not reside in the property (he later argued that this was a misunderstanding), the court concluded that the condo was not the taxpayer’s principal residence. As a result, it was not eligible for the principal residence exemption.

However, another taxpayer with a somewhat unusual fact situation had more success claiming the NHR. This sales tax rebate can result in substantial savings for the buyers of a newly constructed home. In the December 2016 Tax Court of Canada decision, Mohammad Cheema v. The Queen, the taxpayer had applied for an NHR of $24,000 on a home in Vaughan, Ont. The CRA denied the claim.

The issue centered on the unusual legal ownership of the home. Although the taxpayer and his wife took a 99% legal interest in the home, and paid all the expenses of the mortgage and other costs of ownership, a friend of the taxpayer — approved by the lender — signed the agreement of purchase and sale to help with the financing.

As part of the deal, which was done purely to help the taxpayer secure a mortgage, the friend became one of the home’s legal owners, with a 1% interest. On the closing date, the friend and the taxpayer also signed a separate trust declaration, stating that the friend held legal title only, in trust for the taxpayer and his wife, who were stated to be beneficial owners. The friend stated during the litigation that he never had any intention of occupying the property.

The section of the ETA dealing with the rebate requires that the applicant-homeowner must occupy the property, as the legislation’s policy goal is to avoid non-occupying owners, who may be speculators, receiving the rebate. The CRA, concluding that a legal owner of the property in this case was not an occupier of the property, denied the claim.

Generally, the tax court has agreed with tax officials that the NHR will be denied in cases in which a third party co-signs an agreement of purchase and sale — even when the co-signer is part of the deal purely to assist with the financing. However, the court departed from that practice in this case and concluded that the taxpayer’s claim should be allowed.

In particular, this decision emphasizes that: the taxpayer and his friend gave credible evidence; they did not intend the friend to have any meaningful interest in the property; and they relied on legal advice to structure their deal by creating the trust.

“While the Minister has argued that the [NHR] provision does not allow the use of bare trusts, I am of the view that there are good reasons to conclude that the statutory language also does not exclude it,” Justice Guy Smith concludes in the decision.

Although alternative types of arrangements for owning, financing and occupying a residential property may still permit the use of these tax benefits, these recent Tax Court of Canada decisions indicate that clients claiming the benefits must use great care in structuring and documenting the terms of these transactions.